The long weekend…

While perhaps not comparable with the assassinations of John F Kennedy and Dr. Martin Luther King Junior, or the horror of 9/11, the weekend during which Lehman was allowed to fail and the rescue of AIG was arranged will certainly scar the memory of all those who were in the finance industry at the time, as well as of all who suffered its consequences.

With hindsight, to quote Wellington after the Battle of Waterloo: “…[it was] the closest run thing you ever saw in your life”. Unlike during the Great Depression, there were no material bank runs (at least in the US), although anecdotally those were averted more by happenstance than direct action, but the Federal Reserve, acting on behalf of the US Treasury, subsequently pumped literally hundreds of billions of dollars (and, ultimately, trillions) into the financial system and economy; and the GSEs, Fannie Mae and Freddie Mac were effectively nationalized, as was AIG. Lehman’s disorderly failure was, however, the catalyst.

While the merits or otherwise of whether Lehman should have been allowed to fail are still hotly debated, and arguably it would have been a lot “cheaper” to rescue the firm, the decision was a political one, not a rational economic one. The politicians were worried about being castigated for “bailing out the fat cats” as they were when JPM Morgan absorbed Bear Stearns. In view of what subsequently happened, a little more intestinal fortitude might have been in order, even if socializing risks accumulated by private capital is morally distasteful.

Naturally, this post is one of probably hundreds of articles that have appeared recently. So one might ask- to what purpose? Who cares?

Well, anyone who has any exposure to the financial system (and everyone does, directly or indirectly) should care. Most wealth is now not held in material form, or as “cash under the mattress”, but in the form of de-materialized claims, almost all of which exist in the books of a private financial institution. Very few of us have the privilege of, literally, having an account at the Fed or the Bank of England.

So, it behooves anyone who cares about the long term welfare of themselves, their business or family to consider whether much has changed since the dark days of 2008-9; what might signal the onset of another financial crisis (and there will be one- they occur frequently); and how they can protect against the consequences.

Awbury’s business was built in the aftermath of the GFC, because its creators saw that while fear, uncertainty and dislocation were widespread, economic life would go one; the need for sophisticated and bespoke solutions to credit, financial and economic problems would not go away; and thus there was an opportunity for an experienced, diverse and disciplined team of credit underwriters and managers to create a franchise. While, even in the face of reasonable success, we remain habitually paranoid, almost 7 years later that is exactly what we have done.

Of course, when we start hearing the phrase “this time it’s different” uttered regularly, we will know that the time is again approaching to batten down the hatches, drop the storm anchors, and be prepared to ride out the approaching storm- even if its precise origin and direction remain unclear. The aim will be to be in a position to “buy” when it passes. During a Wharton seminar, James Dinan of York Capital recently amended an oft-repeated Rothschild dictum (also from the time of the Battle of Waterloo): “The best time to buy is when there’s blood in the streets, but not if it’s your blood.” He also commented: “Credit investors smell the fear before equity investors do.”

Ten years is still, in one sense, quite a long time in the course of a human lifespan. People tend to forget, or become complacent. They should not.

The Awbury Team

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Ten Green Bottles…or Last Person Standing…?

The current open season on (re)insurance M&A, brought to mind the children’s song, with its image of objects falling one by one. Alternatively, one might start to wonder about who, amidst all the activity and the apparent significant narrowing of the pool of available “targets” will remain the last person standing.

We are sure, as the industry heads to Monte Carlo for several days of frenzied meetings and hospitality, that speculation will be rife as to whether further transactions may be agreed at 3am, in venues carefully screened from the Tables.

Already this year AIG has acquired Validus; Axa should shortly complete its acquisition of XL; while Aspen is likely to disappear into the portfolio of the Apollo Group. The market capitalizations or likely acquisition price of those peer entities which remain independent certainly opens them to being in the sights of a range of potential acquirers, with none invulnerable in simple economic terms to a bid.

As S&P pointed out in its recent “Bulking Up: The Global Reinsurance Sector Marches Towards Consolidation” report, the entire sector faces tough market conditions and structural changes, which weaken competitive positions (as well as lower returns on equity- largely mediocre at best), driving senior executives to seek cover in M&A activity and an attempt to increase premium flow through a supposedly more efficient cost structure and a broader range of product lines.

The problem is, if everyone is doing it, what is really going to differentiate the “thrivers” from the survivors, let alone the obsolescent zombies hoping to shuffle along without being finally put out of their misery? It is a truism of corporate lore that many mergers do not deliver the promised “synergies and efficiencies”, and are often value destructive because vested interests (and self-preservation) prevent the implementation of truly radical actions which could deliver clear benefits.

Of course, the reinsurance market, while it contains a number of “big beasts”, is hardly dominated by them, as they are not able to extract rents because of the availability of alternative capital. The market still remains quite fragmented even after years of consolidation. This then begs the question of whether reinsurance M&A is now “offensive” or “defensive”. In most cases, it appears defensive, as the acquirers are trying more to protect themselves against increasing market pressures, rather than gain capabilities that will truly enable them to break away from the pack.

In reality, no-one is going to be surprised by the next M&A announcement as long as the current patterns and behaviour persist. There is little or no originality being exhibited, with most of the excitement now arising in the form of Insurtech investments, and attempts to change business models internally. If that is the case, one could argue that a potential acquirer’s management should ask itself some hard questions about the true purpose of an intended acquisition and how it will truly improve the acquirer’s competitive position.

It seems to us that, while there may be a need for some “one stop shops”, there also remains a clear need for innovative business models that break away from the realm of the “expected” and deliver products and services to their clients that the “big beasts”, weighed down by their often bureaucratic structures and processes, find it hard to provide.

The Awbury Team

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